Italy’s sovereign debt has been downgraded by credit rating agency Moody’s, because of growing uncertainty among investors about Italy’s public finances.
This is not the first time that markets have expressed anxieties about Italy’s gigantic sovereign debt, which now amounts to 1,900bn euro.
Italian Prime Minister Silvio Berlusconi has stated that the move was largely expected.
Already, on 23 September, credit rating agency Standard and Poor’s had placed Italy’s debt in a higher risk category.
It was only a matter of time before Moody’s would follow by downgrading the country’s debt from an Aa2 to an A2.
The credit rating agency claimed its decision was primarily motivated by the euro’s general fragility. It explained that general loss of confidence in European sovereign debts would inevitably have increased Italy’s cost of borrowing.
Moody’s stated that the growing concerns over the risk of holding Italian debt, made the downgrade necessary, although the agency emphasised that the possibility of an Italian default remained remote.
Moody’s decision was also based on the Italian economy’s poor growth prospects and the general structural rigidities of Italy’s labour market, which leads the agency to believe that, unless credible steps to foster competitiveness are taken, Italy’s expected debt-to-GDP ratio will not go down from its current 120% figure.
Italian finance minister Giulio Tremonti, on the other hand, believes that Italy’s public finances are solid, even with zero growth, and that the epicentre of the Eurozone crisis is to be found not in Italy but in Athens.
This statement may contain some truth. Unlike Greece, Italy runs a primary budget surplus, meaning that, leaving aside the costs of servicing its debt, the difference between government revenues and expenditures is positive.
Nevertheless, fiscal consolidation has mainly been achieved through austerity measures consisting of budget cuts and tax hikes. Moody’s believes that the issue of growth has not been sufficiently addressed.
Additionally, the agency states that, given the current weakness of the centre-right coalition headed by Mr Berlusconi, further austerity measures may be difficult to implement, calling into question the political capacity for tackling the issue of government debt.
European stock markets appeared to be largely prepared for a further Italian downgrade. Despite the bad news coming from Rome, major stock market indices in London, Paris, Frankfurt and Milan went up, demonstrating market confidence in the EU’s recent efforts to save the common currency.
Confirming these expectations, today’s Financial Times featured an article about a plan by European institutions, which would possibly involve a major recapitalisation of continental banks.
If this were to happen, a coordinated European action designed to support banks against sovereign insolvency would make heavily indebted countries like Italy more immune to financial shocks, and would restore investor confidence.